This is part of a series that I’ve been working on called Understanding Venture Capital.

In one of the posts I spoke about how the size and vintage of funds might affect you when you’re raising money.   This led Roy Rodenstein (whose company Going.com was sold to AOL) and others to discuss, what happens when VC’s need to invest across multiple funds.  Specifically Roy commented

“your company may go long enough that its vintage fund gets cramped and you may get painted into a corner for followons. Even more complicated, VCs often invest from multiple funds or sub-funds into a single deal. So as an entrepreneur it’s hard to navigate those waters over time. As usual the rule is, if you’re doing well, they’ll find the money for your next round.”

Everything that Roy mentions is true.  And VC’s don’t like to invest across multiple funds.  I thought I’d do a quick post on why VC’s don’t like to cross funds so entrepreneurs can better understand the situation and how to talk with their investors about it.

As a reminder, VC funds are comprised of money from LP’s (Limited Partners) that include university endowments, pension funds, high-net-worth individuals, insurance companies and large corporations.  In a single fund of $100 million you might have 30 difference LPs.  So if a fund was raised in 2006 and the next fund was raised in 2010 it’s possible that they have two funds that “cross over” at the same time.

It’s technically possible that the VC still has a couple of new investments left from their old fund or even more likely it’s possible that they invested in your company from the end of Fund 1 and subsequently raised Fund 2.  In a perfect world they “reserved” enough money from Fund 1 in order to continue to invest in your company from just one fund.  But it’s possible that they have to “cross over.”

Why does the cross-over matter? As it turns out some of the LPs in Fund 1 might not have “re-upped” (e.g. invested again) in Fund 2.  It’s also possible that some new investors joined Fund 2 that weren’t in Fund 1.  So there isn’t a 100% correlation of investors across funds.

So if Fund 1 invested in your first round and Fund 2 invested in your second round, you can imagine the following scenarios:

- An investor who is only in Fund 2 wonders why the VC invested again in your company.  Is their money being used to “protect” the investment that was made from Fund 1?

- Conversely, let’s say there is an investor in Fund 1 who didn’t “re-up” for Fund 2.  He might be thinking, “whoa, you’ve got this killer portfolio company where my money was used to invest in this startup and now my money isn’t being used to follow on the previous round so I’m owning less of the company than I should.”

- Now, let’s get more ominous.  Let’s say that the first round of investment in a startup was done at a $50 million pre-money valuation from Fund 1 but the company has severely underperformed.  A totally new VC is willing to invest in the company but at a $15 million pre-money valuation.  A condition of their investment is that the initial VC continue investing alongside them.  And let’s say that VC now needs to invest from Fund 2.  In this case the second fund might actually be used to “crush” the money from the first fund.

Given all of the conflicts you can see why investors would want to avoid crossing over funds.

How do they deal with these types of situations? First, VC’s have “advisory committees” that consist of a sub-segment of their LPs.  These groups meet regularly to discuss fund issues such as “how to value the portfolio companies” and to get input on issues like “whether the VC is investing outside of its normal scope.”  If it’s a simple cross-over issue the VC might bring the issue to a special advisory committee meeting.

For issues that are more complicated (such as the last scenario above) VC’s have something called a “conflict committee” that is designed specifically for issues that might be perceived as conflicts of interests.  You can see clearly how this could be the case in scenario three.  The conflict committee will help the VC decide what to do.

But here’s the thing.  Most VCs like to raise their next fund from existing investors.  It’s less risk and makes fund raising much easier since the LPs already know your firm.  So VCs avoid these types of scenarios any time possible.

So how should you deal with this issue? Just make sure to know how big your VC’s fund is, what vintage it is, how many investments they have left in their fund, how much they’re “reserving” for follow on investment in your company and when they’ll be raising a new fund.  You can’t just blurt out these questions because they’re sensitive topics.  But when a fund offers you a term sheet and is interested in investing you can politely and cautiously approach some or all of these topics.

And if the VC is “at the end of their fund” and about to close a new one I would strongly recommend you talk to them about the “reserves” they have for your company and how they would deal with the issue of investing across funds if it were ever required.  Hopefully it won’t be.

Note: I don’t have experience in dealing with these issues in 100′s of funds so it’s possible that other VCs have slightly different points-of-view.  If anybody has any more information or thinks about these issues differently please feel free to add in the comments section.

This is part of my ongoing series on Understanding Venture Capital.

I recently wrote a blog post on understanding how the size and age of a venture capital fund might affect you when you’re raising money.  Because it is a “series” I plan to get into some of the deeper complexities of funds such as “cross over funds” and “why VC’s hate to price their own deals” at a later stage. The last post was a high-level primer.  I know many super experienced entrepreneurs who don’t understand the basics of how fund size and age can affect them so I thought it was worth establishing a baseline.

Chris Dixon provided some commentary on Twitter that he believes my last post missed “the most important point about fund size.”  He’s specifically referring to his point of view that entrepreneurs shouldn’t take seed money from “big VC’s” (he defines them as > $100 million).  It actually wasn’t the point of my post – my point was just to get people thinking about the issues of size and age in the first place.

But I understand Chris’s sentiment and in certain situations I agree.  But while he’s directionally right that there are risks, he’s wrong to rule out all VC’s who do seed investing.  Yes, I’m a VC who does seed investing so I have a bias.  But Chris is a seed investor who competes for deals with VCs so the bias runs both ways.  I bet if we discussed the issue live we’d probably end up agreeing more than disagreeing.

Let me elaborate:

1. The problem with VC Seed Funding – Chris is right to raise the issue with entrepreneurs because there have been instances where large VC funds have set up seed programs where the investments have been used as “options.”  There are many problems with this.  First, if the VC does 15-20 of these under one partner then it is certain he can’t spend any time with these investments.  And they don’t.  I believe these VC funds have suffered some amount of reputation fall out.  In a world of The Funded, VentureHacks and entrepreneur blogs this kind of information spreads like wildfire.

Second, more damning is the “signaling problem.”  This means that if a VC invests in your seed round and does not participate in a future round the next round investor will think to himself, “well, if Big VC Co. invested in the seed round they have more inside knowledge than I do.  If they’re not willing to fund the next round then something must be wrong with this company.”  This is true and does happen.

Third, he notes that even if they do invest they’re likely to do so at a lower price because you can’t truly get an independent valuation.  He says that if somebody new looks at the deal they’re likely to call the seed investor and collude on a price that is artificially low.  I’m sure this happens, too.  But I’m also sure it doesn’t happen all of the time.  As always it comes down to competition.  If you have several new investors looking at your company you’re likely to get  higher price.

2. Why are VC’s really doing seed deals? There are several reasons why VCs are doing seed investments.  One of them is simply that more entrepreneurs don’t require as much money to get through their first milestones.  When I was first starting companies in the late nineties it took $3 million just to get version one of our product out the door.  We had to buy expensive Sun servers, Oracle databases, Unix licenses and build complex software.  Bandwidth and hosting charges were expensive.  These days solid entrepreneurs can get their companies through the first 12-18 months for $500-$750k.  So if a VC wants to work with really talented early-stage entrepreneurs there are times where they have to be willing to seed fund them in order to be in the deal.

This was the exact case on my first two seed deals (and as a $200 million fund I fall into Chris’s “big” status – although I certainly don’t feel that way ).  My very first seed deal was a company that told me flat out that they didn’t want to raise more than $500k.  We offered them more : $750k-1 million.  They said that they didn’t want the extra money or dilution.  We took the $500k.  We used the Y Combinator open source term sheet.  We signed the term sheet within 48 hours and had funded in under 2 weeks.

How did it go so quickly?  I knew the team for 2 years and had tracked their company through to pre-launch.  We funded it just before they took the wrappers off of the company.  They were grateful for the extra money as their launch was overwhelmingly successful and they had to rapidly hire staff to support customer demand.

It’s true that some VCs view seed deals as options.  I do not. I’m not the only VC who feels this way.  The deal I described has gotten just as much attention from me as the A round investments I’ve done because I haven’t done 15-20 seed deals – I’ve done three.  The seed nature to me are just the size, price and risk factors – not a pure “option” to see what happens.

3. Signaling problems always exist - What Chris doesn’t make clear is that signaling problems exist with nearly EVERY investor.  If you raise angel money that’s another story.  But if you raise from any fund and unless the fund has a 100% consistent policy that they will absolutely never do a follow on investment then a signaling problem exists.

Let me give you an example.  A very well known early stage fund used to have a rule that they didn’t do “follow on” investments.  Life seemed easy as they told all investors that their model was to lead the first round and not to follow on.  The problem is that all investors speak with each other.  And I learned through the grapevine that they had done a very small number of follow-ons for their most promising investments.  They didn’t announce that – it just happened.  So once I knew this my obvious question on the deals that I looked at was, “ok, are you investing?”  You can’t avoid it – signals always exist unless a fund is 100% absolute in its rules.

Or … you raised your $500k from angels and now are ready for a VC “A” round.  You’re trying to raise $3 million at a $6-7 million pre-money (e.g. “A” investors will own 30-33% of your company).  Well, if you raise that VC money you’ll have the signaling problem if they fall out of love with your company in the future because you’re not performing well.  The reality of raising venture capital is that you’ll always have some signaling risk- frankly, there’s almost no way around it.  It’s an occupational hazard.  Your best antidote to the signaling effect, I’m afraid, is to perform reasonably well.

Let me give you another example.  Let’s say you’re an EIR (entrepreneur in residence) at a VC firm.  You were there for 9 months and then you left and created a company 15 months after you left.  If that VC doesn’t invest people will ask why.  That’s signaling.  You’ll have your reasons and some VCs will get beyond that.  But it’s a signal nonetheless.

Different scenario:  You’re on your second company.  A prominent VC funded your first company but isn’t currently investing in this company.  Think that’s not a signal?  Think again.

Or you’ve never done a startup but your last boss from Google, Facebook or Yahoo! is now a VC.  Many are.  They didn’t invest in your company?  Signal, signal, signal.

OK, so your boss didn’t become a VC.  You were a VP at a startup company that sold for $100-200 million making the founder very wealthy.  You’re startup raised angel money and is now looking for VC.  That founder wasn’t one of your angels.  Think that the VCs looking at your deal won’t wonder why?  Think they won’t call him?  Signal.

It’s very hard to completely get around the signaling problem.  It always exists.  I agree with Chris that it is more prominent when a big VC invests in the seed round of your current company and doesn’t follow the investment.  But if you raise money from a small seed fund and they don’t want to follow (and you’re not able to immediately raise new money) you’re equally screwed.

3. The problem isn’t whether or not to take seed money from a big VC, it’s which VC you are working with – I’ve written about good VC seed investors before in this post about taking seed funding from VCs (if you’re very interested in the topic it’s worth a read even though it’s similar to this post).  Fred Wilson of USV invests in seed deals including in Foursquare where they split a $1.35 million investment with O’Reilly Alphatech Ventures (OATV).  I think Fred qualify as both an active investor and one in which you’d be delighted to have on your team.  He’s also an investor who isn’t shy about following on at deals in which a new VC does not come into the next round.  And he works at a “big” VC.

Brad Feld at Foundry Group also invests in seed deals (this is a great post worth reading on Brad’s views of seed deals).  In fact, 7 out of Foundry’s first 16 investments were seed deals.  Foundry is both stage agnostic and syndication agnostic.  They don’t mind being the lead investor on deals that they seeded.  How many entrepreneurs wouldn’t kill to have Brad and/or Foundry in general involved with their company.

First Round Capital meets Chris’s definition of a “big fund” and they do seed and A round investments.  They also do follow ons so Chris’s point about signaling exists with FRC as it does with most investors.  I’ve never met a FRC CEO has has anything but positive things to say about the fund and their involvement with portfolio companies.  Sometimes they’re “over the top” effusive about FRC!  FRC is the most innovative VC out there now.  They’ve found a way to get leverage for their high volume of investments by running CEO Summits and special industry events beyond what many VCs provide with their lower volume of investments.

Same with True Ventures.  Their entrepreneurs are evangelical about how great it is to be part of True’s portfolio.  Big fund.  Great reputation.  Seeds deals.  Would you not take money from them?  I would.  In fact, I nearly did at my second company but we were bought by Salesforce before we raised our round.  True was my top pick to work with in Silicon Valley.  They seemed to have a different way of working than most VCs, which I found appealing.  And I know that True has done some very small seed deals as well as some larger A round deals.  They seem to be managing fine with both models.

And then there is my firm, GRP Partners.  I’ve made 3 seed investments out 5 total investments over the past year.  Two of the three were at the founders’ request.  In one of the three instances the company is now raising more money.  I proactively offered the CEO to fund the company without any other investors having to come into the deal to lead it.  I gave him what I consider a very fair price.  I then told him, verbatim, “I feel this is a fair price.  You’re more than welcome to shop around on Sand Hill Road for as long as you want.  I’ll take the whole round, half of the round or my prorata.  If you shop it be aware of a few things: 1) your information will be widespread in Silicon Valley including amongst your competitors (this is just a reality) and 2) it’s likely to take 6-8 weeks to get through the process if you’re doing well.  If you accept my terms you’re done.  Cash in bank in 30 days.  Your choice.”

It wasn’t an easy decision for the team.  It was sincere in my offer.  They elected to sign my term sheet.  Chris might say that they could have gotten a higher price had they shopped it.  He might be right – we’ll never know.  But the highest price possible is not always the best outcome for the company.  I gave them a “high” price by Chris’s definition in his post on not taking seed money from VC, but I didn’t give them a “Foursquare Price.”  But importantly, there was no signaling effect.  By offering to take half the round or my prorata I fully enabled the company to do whatever they needed to do.

Entrepreneurs – please take note.  I know you’ve all read Chris’s post because so many of you have told me so.  He makes many great points so if you haven’t read it you should.  But the reality is that in life it’s far more important to look at the whole picture.  Make sure you know the reputation of the people you’ll be working with.  I’ve covered that topic in this post on how to reference check your VC.   If they blog make sure to read what they think because they make much of it known in writing.  I’ve made my entrepreneur thesis clear.

It’s not black-and-white.  It’s more important to pick wisely with whom you work at an early stage.  Whom you work with is more important in my opinion than it is whether they’re a seed fund or a VC fund.

4. The plus side of good VC’s doing your seed round - I just want to hit one last topic that is worth noting.  There is one point that Chris leaves out of his post.  There can actually be a positive side of a “good VC” doing your seed round.  I like to talk about seed investments with entrepreneurs in these terms:

a – if your company sucks wind don’t think that you’re guaranteed to get a follow on from me or from anyone else.  if you completely miss the target you’re dead no matter whom you raise the money from.  So a good VC fund or seed fund or angels in this case is all neutral.  You’re forked either way.

b – if your business is “killing it” (e.g. doing really well) then it also won’t matter.  Do you think companies like FourSquare or Gowalla would ever struggle to raise follow on rounds if their early stage VC’s don’t follow?  Or for that matter can you imagine their VC’s not following?  If you’re doing well you’ll have demand

c – so for me the most telling case is when you’re doing “ok” but you haven’t hit major proof points yet.  This is actually what happens the majority of the time at startups so if it’s you, you’re in the norm.

In the “c” case (50%+ of outcomes) let me point out the following.  It’s far easier to get an extra $500k out of a $200 million VC fund to get to your next milestone than it is to squeeze $500k out of 5 angels if they’re not sure you’re performing well.  They often judge your performance on whether VCs show interest.  How’s that for a dilemma?

And more to the point – if you hit a major economic down cycle (like September 2008) you’ll have tough times with all investors.  But it will be much easier to get a small bridge from a VC than one from angels.  Why?  Because angels will have their money in real estate, the stock market, etc. and a VC’s fund has one purpose – startups.

And the final argument I hear is, “I’ll just do angel money now so I can shop my next round to a big VC at a high price.”  Um … that’s fine in scenario “b” above.  In scenario “c” – good luck.  I’d much rather have the fund on the inside and on my team with the ability to bridge me than on the outside.

I am a fan of raising angel money and often tell entrepreneurs to do so.  What I like most is that if your company has an opportunity for an early exit most angels would be delighted.  I’ve written about the fact that I feel most businesses should never raise VC.

But if you plan to try and build a big company then involving good VC’s early can be a benefit.  I think you’ll be just fine taking their money in your seed round and if it’s a small round I don’t believe most good VCs would block an early exit.

And for reference, most “good VC’s” will work with seed funds and angels in seed deals.  In my first deal we took angel money in the seed round (from 2 angels) and an early-stage co-investor in the A round.  In my second seed deal I did the whole round for expediency.  In my third seed deal we co-invested with a seed fund and then syndicated the rest to strategic angels.

And if I ever got the chance to work with Chris Dixon’s fund I’d be delighted.  I like the way he thinks.

This is part of my series on Understanding Venture Capital.  I’m writing this series because if you better understand how VC firms work you can better target which firms make sense for you to speak with.

It is not uncommon to see a VC talk about “total assets under management” as in “We have $1.5 billion under management.”  I don’t really understand why VCs do this since it’s mostly a meaningless number.   I’m writing this post to explain to entrepreneurs what you should be thinking about in terms of the VC’s you approach and the size and stage of their funds.

What is total assets under management? - VC’s often talk about this term as in the total amount of funds EVER raised by that VC.  Example: if a VC is on their fourth $200 million fund that they just raised in 2009 then you might hear them talk about $800 million under management.  This is ONLY relevant in so much as it will tell you that they’ve been able to raise a lot of money historically.  But without knowing whether they had a $700 million fund and now have a $100 million fund or whether they’re a first time fund of $800 million it’s pretty meaningless.  It’s also meaningless if they had four $200 million funds and the last one they closed was in 2000.

What is a VC fund? – I’ll do a detailed post at a later date but to make sure that everybody has a baseline understand for the more important details of this post I’ll touch on this topic here.  VC’s don’t invest 100% of their own money.  They raise money from institutions who want to have some allocation of their investment dollars in a category known as “alternatives,” which is supposed to mean higher risk, higher returns.  Unfortunately over the period of 2000-2010 the VC industry hasn’t performed well and therefore the number of funds going forward is likely to reduce greatly.  VC’s raise this money from university endowments, public & private pension funds, insurance companies, banks who invest from their balance sheet or that of their wealthy clients, “family offices” which means money from very wealthy people, etc.  And funds also have investments from the partners of the firm.  Most funds are 10 years in length and the initial investment period is normally 3-5 years.  So VCs often raise money every 3-5 years if they can.  Some wait 5-7 years but usually this is because it’s proving more difficult to raise a new fund due to market conditions or the lack of returns in their current fund.

What IS relevant about the size of a VC’s fund? – The most relevant thing for you to know about size is the dollars of the CURRENT fund.  For example, my firm, GRP Partners, has a $200 million fund that was closed in March 2009 and we have 4 investment partners.  Our prior fund was $360+ million and the fund before that was around $200 million.  The size of those prior funds doesn’t really matter to you.  What you really want to know is that our current fund is $200 million and you want to know when it was raised (covered in next section).  If a fund has a $25 million fund then you know they aren’t going to be writing $5 million checks!  A fund size of $25 – $100 million is normally an “early stage” fund that is likely to do seed investments and/or smaller A round investments.  A fund size of $100 million – $200 million is likely to either be an A round investor or “stage agnostic”.  An A round investor implies they are the “first institutional money in the deal.”  GRP Partners is stage agnostic.  We’ll invest $500k in a seed stage deal, $2 million in an A round or $8-10 million in a B round investment or later.

If you see a fund of $600 million you can bet that it’s harder for them to do $1 million investments so it won’t be uncommon for you to hear them talking of “putting more capital to work” which is code for “I can’t really get out of bed unless I’m putting at least $2-3 million into your company.”  It’s not always the case.  But it’s worth your knowing that the larger the fund size the more pressure the fund will have to shy away from investments that are too small.  You can always talk to your VC about the “stage” (seed, A, B, C) of deals they like to do and their “typical first investment size.”  All quotes in this post are VC lingo.

Understanding the fund vintage – “Vintage” of a fund refers to when the fund was raised.  A 1997 vintage is likely to perform much better than a 2000 vintage because the former got to ride the dot com bonanza and likely saw some quick IPOs and crazy trade sales while the latter is more likely filled with many companies that never reached the promise land (or are still trying).  Why does vintage matter to you? If the VC your talking to raised its last fund in 2002 then they likely don’t have much fire power for new investments.  I wouldn’t say the have NO firepower but it’s not likely a lot left.  If you imagine that they did most of their initial investments between 2002-2007 then it’s been 3 years of mostly doing follow-on investments in those old deals.  Also, since most funds are 10-year funds there will be pressure in 2012 for this fund to start exiting its investments and return money to its shareholders.  Most funds get annual extensions.  I’m not an expert in this fields but ironically I’m finding the most “10-year funds” are really more like 13 year funds.  But let’s just say I wouldn’t want to take an A round investment from a firm who is in year 8 of their fund without really understanding this.  If they’re likely to raise a new fund then you might be OK but at least have the conversation with them.  And know that raising new VC funds right now is incredibly hard.

How much of a fund is actually invested in new deals? – If a VC has a $150 million fund (let’s call the VC-A) to  they might only invest $75 million in new deals. Maybe even less.  Let’s say a fund invests $1 million in an A round deal in a company called NewCo.  That fund “reserves” money for NewCo’s “follow on” investments.  In an early stage deal that fund might reserve 2x their initial investment or if it’s a larger round or later stage they might reserve 1x.  In the 2x example that means that VC-A has really blocked out $3 million from their fund ($1 million invested, $2 million reserved for NewCo.)  They might never invest that $2 million and over time they might adjust that reserve (up or down).  The main take-away for you is that a $150 million fund is not $150 million of new investments.  You want to know how much money is “not reserved.”

Knowing the “number of deals left in the fund” – VC’s typically talk among themselves about “the number of deals left in their fund” as in a $200 million fund with a vintage of 2006 saying, “we have about 4 new deals left in our fund.”  In that number they have to include the amount of the new investment they plan to make plus the amount they would reserve for those new investments.  VC’s don’t publicly state this number so don’t expect to find it on their website and don’t blurt out the question in your first meeting with them.  But know that for funds that aren’t closed within the past 3-4 years … the VC will know this number.

Will your VC be able to raise another fund? – That’s a tough question that as of 2010 is a hard to know for certain.  The industry is in turmoil, for sure. Paul Kedrosky wrote a seminal paper for the Kauffman Foundation saying that the VC industry needs to shrink by 50%. Fred Wilson also wrote a sophisticated analysis of why he believes the market must normalize to smaller amount of money going into VC firms.  Fred echoes my view that fewer firms is good for the industry and good for the companies we fund.  Irrational prices and over investment in your competitors hurts your ability to build healthy businesses.  I saw it myself in 1999-2002 when it was hard to charge for my product because all of my competitors raised large rounds of capital and were giving away their products free fueled by large VC rounds.

If a VC fund you’re talking to raised a fund in 2005 or early and hasn’t yet raised a new fund they certainly will be thinking about it and trying to figure out how and when to raise a fund.  What will matter are: whether the people who invest in VC funds (LPs or Limited Partners) increase their activity and the performance of that actual fund.  What the LPs will be looking for are VCs with enough “exits” to prove that they can make returns.  So look at the latest portfolio of your VC (not prior funds) and see whether they’ve had exits and how many of their non-exited companies are likely to exit in the near future.

I wouldn’t rule any decent firms out.  I know many great funds that haven’t yet raised their new fund but may still get there.  A lot will depend on how exits go in 2010/2011.  GRP’s last fund was in 2000.  When GRP talked to LPs about a new fund in 2005 the feedback was “get some more exits in your fund and then come back.”  That’s what many VCs are hearing in 2010.  I’m happy to say that in 2006-2008 we has some good exits including BillMeLater, DealerTrack, UGO Networks and PrePay Technologies to name a few.  We also took one of our large portfolio companies, Ulta, public.  Our 2000 fund is now performing significantly above industry averages and therefore we were able to raise a new fund in tumultuous times.

How and when can you ask all of these delicate questions – You can’t blurt out all of these questions in your first meeting.  But you can do some focused Internet-based research before approaching the firms.  You can ask around to startup lawyers and other entrepreneurs who know these things.  And if your friendly with somebody at a VC firm they usually know the high-level details about the other firms.  The right time to start asking about these sensitive questions is when the VC starts showing interest in your company.  Ask delicately and respectfully.  But make sure you answer all of the important questions about when their last fund was raised, how big the fund size was, how many investments are left and when they will likely raise their next fund (assuming this fund wasn’t closed in 2007 or beyond).

In the past I’ve written on the topic of “Raising Venture Capital” but today I’m starting a new series called “Understanding VC’s.”  My goal is writing this series of to make it easier for you as a startup needing to raise money to understand how venture capital firms work so you can be more efficient and more effective in your process.

In today’s post I want to talk about the concept of a VC flightpath.  This is my description of a VC process, not one I’ve heard from other VCs so don’t expect it to be accepted nomenclature.  But I use this all of the time as a metaphor when talking with entrepreneurs in person and I’ve found it to be a useful way of explaining to entrepreneurs what is going in in the VC’s life.

When you visit a VC to tell them about your wonderful idea it’s easy to imagine that this person is not evaluating any other deals at the moment.  I have no idea why, but that’s always how it always felt to me when I was an entrepreneur raising money.  Of course I knew that they sat on other boards that kept them busy but somehow it seemed like I had all of their attention to myself during the fund raising process – especially the ones who seemed to like me and spend time with me.  Even when you’re getting the VC love this reality I imagined couldn’t be further from the truth.

Imagine your VC as an airport.  Imagine he or she sits on the boards of 5 companies.  Those companies are the planes that are already on the tarmac and many of them are loading / unloading other passengers.  They’re obviously garnering a fair amount of attention from the airport staff.  You can easily know which planes are on the ground as they’ll almost always be listed on the VCs website.

What’s less clear is which airplanes are in the sky and waiting to land.  The VC might have an airplane on final descent (e.g. a term sheet has been signed, the legal documents are being drafted and the deal will close some time in the near future).  If a VC has an airplane that is currently landing then you can be pretty sure that they’ll have a lot of their attention making sure this plane lands safely and this may make it more difficult for you to get a landing slot in the short term.  Assume that your VC has more than one runway but each partner only controls one runway so if you’re talking to the partner who’s in the airport tower guiding in the descending plane it’s not likely yours is going to get cleared for landing.

And while there are likely at least two runways at your VC firm’s airport they probably have 4-7 partners vying for those landing spots and terminals so even if your partner is trying to get approval to land your plane there are other partners who have their planes, too.  And they might just get a priority landing slot before yours.

So you might have had your first meeting with a VC and he got super excited.  But you’re traveling from JFK to SFO and you’ve only just been granted permission for take off.  If most VCs will only have one airplane landing at any one time they probably have many others that are circling their airport hoping for clearance to land and many more en route.

Let’s talk first about the “holding pattern.”  In my analogy these are deals where the VC has invested a lot of time and is deciding whether or not to proceed with a landing.  There is a lot of congestion in the circling pattern.  Usually there are 3-4 deals with strong consideration.  Since the average VC  partner (excluding higher volume, earlier-stage VCs) only does 2-3 deals per year it is clear they can’t land every deal.  So much of their time is spent in trying to decide which deals in their circling pattern to divert to other airports.  They’d like to leave them circling for as long as possible but eventually the pilots press them to land or divert.

The reason I like this metaphor is because I believe it helps the entrepreneurs to know that the VC’s mind is congested with dealflow of airplanes that they’re contemplating letting land yet such limited runway and terminal capacity that most deals won’t land.  When you’ve had 3 meetings, a partners meeting and some reference calls you’re not likely the only company in the circling pattern.  You need to be aware of that and find a way to get land or get diverted.  As you know, circling patterns suck.  In a future post I’ll discuss the “divert or land” procedure.

I have on many occasions had a few companies in a holding patterns as I did a lot of research on the company and as I shared that with my partners to try and build support for a landing.  But on occasion one of my other partners might be trying to land a 747 one week that consumes most of our attention at that week’s partners’ meeting.  I can always fight for time on the docket to discuss whether my plane should land but sometimes I find it better to wait a week or two until there’s a little less airport congestion.  It’s both out of courtesy to my partners and also out of a need for me to actually get involved with helping to land their big jet coming in.  If one of my companies circling is running low on fuel I might have to make a quick decision and even seek approval during a congested time but if the airplane has enough fuel I’ll usually ask it to circle one more week.

I’m a pretty transparent guy so I usually call the CEO and tell them the situation that another plane is landing.  But don’t expect every partner in a VC firm to necessarily divulge that information.  In a future post I’m going to talk about how I recommend best finding out this information.

But it’s not just airplanes in the holding pattern that you have to contend with.  You have many other plans that are en route from all over the country in various stages of flight.  A typical VC might take between 4-10 new meetings per week.  Some take more, many take less.  But your airplane that is heading from JFK to SFO and is currently above Denver might get preempted by a regional jet coming from Sacramento to San Francisco and even though you took off first he might still land before you.  In fact, it is not uncommon for a totally unscheduled airplane to come in for an emergency landing and consume all of the VCs resources while you’re asked to slow down your speed considerably.  You might call that the FourSquare Express.

UPDATE: To make extra clear given Jason Lemkin’s comments below – it is certainly true that the A+ deals get fast tracking for an emergency landing so paraphrasing a famous statement, “Look at your hands.  If you’re holding a term sheet the VC is interested.  If not, they’re not yet interested” or put differently, “if you’ve been waived on for a quick emergency landing they’re super interested and if not they’re not yet convinced.”  That is certainly true and A+ deals will know they are A+ deals and will get fast tracked no matter what.  That doesn’t mean that deals that have to fly cross-country for 5 hours don’t also get to land – it just means that either: a) you had no prior relationship with the VC so they’re getting to know you, b) you’re company is not yet “hot” and therefore people aren’t fighting over it c) your data has not trending up massively yet or you would be landing quickly or d) the partner is working on another deal and hasn’t yet gotten his head around the fact that you are a high priority deal.

OK, I know I may have gotten a little bit carried away with the airport analogy but here’s the truth:  If you’re talking with any venture capital partner worth their salt they will have lots of other deals competing for their attention.  If they are showing you interest and taking more meetings then they are likely genuinely interested and may even hope to get to completion with you.  But remember that you are competing not only with your partner’s other airplanes looking to land but also with the other partners in the fund who want to land their planes.

As one prominent partner in a well known Silicon Valley VC fund recently told me, “I hate Tuesday mornings.  It’s when I have to call a bunch of excited entrepreneurs and tell them we’ve decided not to proceed” (read: divert them to another airport). “Sometimes they want answers on what we thought was wrong with their business and I try to explain, ‘we DID like your business.  It’s just that we have other businesses we’re talking with that we feel have higher potential.’ ”  In other words, VC’s have a very limited number of landing slots and have to decide which of circling plans are allowed to land.  Invariably interesting businesses get diverted.

Yesterday I wrote a post about how much capital your startup should raise.  In that post I was talking about how it is a bad strategy to be underfunded.  In general when capital is available take it (provided it’s on the right conditions and from the best people from whom you can raise).  It’s also bad to raise too much, too early.  If you’re interested in that topic I cover it in the article linked previously.

I made a diversion in the article that I shouldn’t have taken.  I talked about the Silicon Valley memo that has been circulated for the past couple of years that says you should “fail fast.”  What I said was:

“I’ve even heard people repeat this bullsh*t Silicon Valley mantra about “failing fast” which is horse puckey.  The line goes like this, “well at least you know early that your business isn’t going to work and you didn’t have to waste 2 years and $1 million trying to bang your head against a wall.”  That is so self centered it winds me up.  Tell that to the person who wrote you the $50,000 of their hard earned money and entrusted you to try your best.  Fail fast?  How does your brother-in-law feel about that?

And how do you think the next person who’s thinking about writing you a check going to feel about that sort of cavalier attitude with their money?  Fail fast = quit and give up easy = spaghetti against the wall = no clear strategy going into your business = no ability / willingness to try and pivot as market conditions change = easy way out = today’s management mantra that will be laughed at in 10 years.  Who started this meme?  I say define a strategy, test it up front and pivot if you’re not getting the traction you had expected.  Fail fast on your own dime.”

Obviously when a meme like “fail fast” forms and conventional wisdom builds in support of it you’re likely to get attacked for saying, “the emperor has no clothes.”  But I just said it.  Naked.  I shouldn’t have covered it in the last post because I should have stayed focused on the topic of how much money to raise.  Here’s an example of one comment I received,

“So you think it’s better to plan and build for years without testing it on the market and then make a big splash release and hope for the best?”

Nice logic, hey?  If I say “fail fast” isn’t the right strategy then it must be a long, slow release process, right?  I’m not attacking anybody’s religious beliefs.  I’m trying to enter the debate with what I found to be a very destructive guiding principle that young people have started to believe.  The following highlights what I do believe and why fail fast is wrong:

What is the right way to build a startup?

• Define a market problem that you believe you can solve
• Research this market by doing market sizing, looking at existing products, talking to customers and deciding how you will make money
• Validate that you can make money before starting. This means looking at what your buyer pays for similar products now, what the history of other people who have tried to monetize in this way have experienced, what your costs to acquire customers will be and what you believe you can make over the customers’ lifetimes.  These are all assumptions – nothing more.  I believe passionately that if you don’t do a financial model you shouldn’t spend any time or money building a product.  You want to talk about the ultimate “fail fast” – how about if you fail before you’ve spent any money building product because you validate there isn’t a big enough market or you can’t make money?
• If you believe there is a market then build a prototype product that you can show customers, investors and potential employees.
• From there build the MVP (minimum viable product).  I believe in launching with a small set of features and learning from the market before you spend too much money building out a feature rich product or before you put serious capital to work.
• If you validate that there’s a market then go for it!  If you don’t believe that your product is resonating then pivot and find one!

Why fail fast is wrong, irresponsible, unethical and heartless:

• I’ve read all of the fail fast, fail cheap articles.  I’ve heard the insufferable speeches at conferences.  I understand that many people argue that “fail fast” just means launch products and learn from customers.  Fine.  Then let’s call this “launch and learn” as well as “adjust and pivot” when adoption doesn’t happen.
• The problem is that when you brand something that will be interpreted differently by people who weren’t part of the zeitgeist when the memo went out about what “fail fast” meant then we educate the next generation of entrepreneurs to do things the wrong way
• How do I know this?  Because I have met so many young entrepreneurs who tell me, “we don’t need business plans anymore, they’re a waste!  We’re going to put our product out there and fail fast!” [note: business plan to me does not equal long Microsoft Word document.  It means a financial model that sets a strategy for how you'll make money and spend money] or they tell me, “we’ll launch a bunch of products and see what works.”  That is the old “throw spaghetti against the wall and see what sticks” approach.  It’s intellectually lazy and I doubt many great companies are born this way.
• Worse still I’ve actually heard the following from somebody that is reputable and whom I actually like, who has raised $1 million, “we don’t want to raise $3 million to get to the next round.  Either this thing has legs and will grow fast and we’ll raise at a very large price or we’re going to ‘fail fast’ .”  Me, “What?  Really?  What about the money you raised?  Aren’t you worried about that?”  Him, “Well, what do you want us to do, stick around for 3 years trying to build something that we know isn’t working?”  I can’t make this stuff up.  People think that way these days.  It’s wrong.  It’s immoral.  It’s irresponsible.  That’s hard earned money you’ve raised, not house money at a casino that you get to put on lucky number 16 and see if it comes up.
• As Reece Pacheco appropriately said in his comment to yesterday’s post, “Know who else you shouldn’t fail fast with? Paying customers. My business has a bunch of them, and a lot more users who really depend on our service. They’re relying on us. Failing fast may be an out for our bootstrapped lives, but it’s not an option.”  Think about that.  People gave you money to use your service.  And they’ve invested their time and trust in you.  Failing fast is to disrespect the very customers who placed their trust in you.  It reminds me of the line, “blowing up your customers” and the disrespect bond traders had in the 1980′s for their clients in the book Liar’s Poker (One of the greatest business reads ever.  If you haven’t read it you should.  See the link for a list of quotes from the book including the now ubiquitous, “Big Swinging Dicks”)
• We have taught a generation of young entrepreneurs that “failing fast” is ok.  It’s quick and easy.  It’s a way out so that you can focus on your next big business idea.  Why waste your time on this one?  Don’t get me wrong – failure is OK in my book.  I’d rather you try something that doesn’t work and learn from it then to never have tried before.  I personally think that second-time entrepreneurs are better because, as I’ve written, “good judgment comes from experience, but experience comes from bad judgment.”
• But my message to young folks – if you take somebody’s money you have a responsibility.  I raised too much money at my first company and regretted it.  Long after the Dot Con 1.0 party was over and I knew that I personally wasn’t going to make as much as I thought I would – I stuck around.  I felt a moral obligation to spend this money that I had raised responsibly.  The market changed totally so my assumptions were all off.  Goldman Sachs had told me we would IPO in a year.  That wasn’t going to happen.  But I signed up for making the company work and sometimes that commitment trumps your current economic incentives.  Not forever – but for a period of time.  Taking money = obligation and commitment to try your best to make a return.

How should you deal with a business that isn’t working?  I’m not talking about when your product isn’t working, but your company.  When you know that you don’t have a future.

• Get your cost base as low as you can as quickly as you can
• Communicate early to investors that you don’t think the business can be successful.  Make sure you say you haven’t given up and that you’ll stay to help find a way to find the best possible outcome for the company.  But that you don’t want to raise any more hard earned money if you’re convinced that new money won’t have a good return
• Consider whether there are any buyers for the company.  If not, are there buyers of the intellectual property?
• In the worst case scenario is there a “face saving” exit for $1 somewhere?  This will save everybody from the time, expense and risks of a bankruptcy
• Remember that legally the order of payments (I’m not a lawyer, double check with a bankruptcy lawyer) is employees, creditors, equity holders
• Better that you handle things until the bitter end and preserve your most valuable asset – your reputation
• There is nothing wrong with saying respectfully to investors, “if I can find a buyer for this asset would you be willing for me to take a very small piece of the purchase price so that I can incentivize my team to stay together through this difficult period?
• If the company needs a very small amount of money to get through this shut down period you should ask your investors for it.  Make sure to tell them that it is for a shut down and/or attempt to recover value for the assets.  Tell them you’ll only ask once.  Only ask once.
• Make sure your employees know what is going on.  You have an ethical responsibility not to surprise them.  MAKE SURE that you pay all of their expense reports that are outstanding.  In the dark days of shut downs I’ve seen many junior members get burned.  This is wrong.

So can somebody with better branding skills than I please come up with the new term that we can all use for what we all know we want to see – customer development, MVP, rapid iteration, pivot and learn.

OK, now you can attack me …

One of the questions I’m most often asked is, “what’s it like being a VC?”  I’ve been a VC for nearly 3 years now.  Since I answer this all the time anyway I thought it might make an interesting blog post.  I always start my answer to this question with, “you’d have to be a pretty big baby to complain about being a VC.” That’s true.  Here’s why:

1. I get paid (well) for interesting people to come in and tell me how they want to change the world – Being an entrepreneur is like having blinders on.  At least for the best entrepreneurs.  Some people do the conference circuit too much, get involved in lots of side projects and attend every entrepreneur dinner.  For me that’s always a bad sign.  When I was running startups I felt like a horse with blinders on because I was super focused on the content management market and ignored many other markets.

One of the things that I’m loving about this side of the people is that it really satisfies my intellectual curiosity.  People come into my office several times per week and tell my about their plans for changing the world.  They outline the problems that exist in markets, their approach to the solutions, they update me on competitors and they show me their economic models.  We have debates about how the industries will change / evolve.  It is the equivalent of going to a coffee shop every day and having intellectual debates.  In fact, I often take meetings in coffee shops.  I LOVE this part of my job.

2. If I’m interested I get to spend more time with them, if I’m not I don’t have to – A few companies per month come in that have fascinating business ideas that warrant my spending more time trying to understand their people, company, technology and market.  I get to do a deep dive on their business model, product roadmap and competitive positioning.  If I  meet a company that I don’t find very interesting I don’t have to spend any more time with them.  I’m not saying I don’t spend time trying to help entrepreneurs that I am not planning to invest it – anyone who knows me can attest to the fact that I do.  But let’s face it, as a VC you spend time with whichever companies you want.  As a CEO I had to spend tons of time with clients who ran business operations that were uninteresting to me.  It was my job to be interested.  No more.  You’d have to be a big baby to complain about being a VC.

3. I have no quarterly sales targets for the first time in a decade – For anybody who’s ever been in a company with sales targets you can attest to what a fire drill the ends of March, June, September and December can be.  Not any more for me.  It’s liberating.  I will obviously be judged on my performance.  But it’s measured in years and not quarters.  Don’t get me wrong – I still feel the pressure to ensure that the companies I’ve invested in perform well. So I spend much time with them and trying to help.  But there’s a big difference.

4. I get paid to network – I love meeting people.  When I go to conferences I never sit in the meeting section – I always cruise the halls meeting people.  That’s where I meet interesting people who tell me the truth.  On stage you hear people giving you the marketing version of their company.  I get to politely ask the questions you’d like to ask like, “what were your revenues, how much money have you raised, what are your plans going forward?”  I only do this when I’m interested in the company and when they’re interested in me.  But in these circumstances these are all fair (necessary) questions.

Also, my job doesn’t involve the daily grind of customer complaints, product outages, business partner / channel problems, hiring / firing, etc.  I work hard, don’t get me wrong – more than you might think.  No “golf Wednesdays” for me!  And the VC job has plenty of admin and minutiae.  But I’m a people person and I get paid to spend lots of time with people.  I get to network with angels, VCs, entrepreneurs, lawyers, etc.  I love it.

5. I go where I want, when I want – I can’t overstate the importance of this in my life.  I worked nearly a decade as a consultant – first building large scale IT systems and then doing strategy consulting.  Then I spent many years as a startup CEO.  I was always in a “service” industry.  That means you’re always operating on the client’s schedule.  You get on a plane at a moment’s notice because a senior customer agreed to meet you.  You call in from your vacation because you’ve had a service outage.  I went to Ibiza in Spain with my wife and in-laws before we were married.  They couldn’t believe how much I was on the phone.  We were in the final phases of acquiring a business and I couldn’t just say, “I’ll call you in 7 days when I’m back on the grid.”  There are still time pressures on VCs, so that hasn’t changed completely.  But I do go where I want and when I want a lot more than I used to.

6. I have a T&E account - Enough said.

7. I love spending time with entrepreneurs in the “romantic phase” – I love the startup phase of a business where we’re still romantic about our dreams to change the world.  The problems are much more manageable.  Once my company got to more than 100 employees I felt like I became “chief psychologist.”  That was fine but I prefer the earlier days.  As a VC I spend tons of time with companies at an early stage in their business.  And in stead of one set of issues to deal with I get the variety of discussing issues with many teams.  That’s fun.

8. We have very small teams – When you’re in your twenties you aspire to manage teams.  I think it’s seen as a sign of making progress in your career.  The idea that people “report to you” must validate some primal need.  In your thirties you realize that managing people means you have less time to work on the things that you want to do.  You have hours sucked up in one-on-one feedback sessions, annual or semi-annual performance reviews and you end up spending a lot of time resolving conflicts across your team members.  I still like spending time with our teams – at GRP Partners we have a great team – but I don’t have large numbers of people to be responsible for.  If I decide to take a last-minute trip to spend 2 days on a company due diligence session nobody is wondering where I am.  You’d have to be a pretty big baby to complain about being a VC.

Still, the truth is that I miss being an entrepreneur all the time.  Here’s what VCs don’t get fulfilled now:

1. We sit on the sidelines – The down side of VC is that exact same as I remember in consulting.  Too many VCs see their entrepreneurs almost like pawns.  They speak of “my CEO’s.”  They talk about how this company failed because the management team didn’t listen to my advice and that one succeeded because we helped point them in the right direction.  I think realistic VCs know that we only have an impact at the margin.  Maybe 10-15%.  That’s why picking great teams is so important.  And I think that too many VC’s don’t realize that the entrepreneurs are our customers – but that’s a separate topic. I hate not getting to own results.  We have a great board chat and talk about our strategic direction but then you go out and execute.  You get the good and the bad.  Those high highs and low lows are your own.  You live them, breathe them.  We live vicariously through you.  It’s like the manager of a basketball team.  We secretly wish it were us that got to take that 3-pointer with the clock running out.  And we’d love the rush of the teammates holding us in the air if we sank it.

2. There is less team camaraderie – I really get along with my partners well.  I knew them for 8 years before I joined GRP.  We end up out a lot at events: dinners, cocktail parties, conferences.  We travel together.  We spend the entire day together on Mondays in our partners’ meetings and seeing companies present.  Still, it’s different in a startup.  When you’re preparing to launch your company at TechCrunch50 and everyone pulls all nighters for the days leading into it you’re building much deeper camaraderie than exists inside of VCs.  When your site crashes and you get slammed by customers and in the press – you’re all in the sh*tter together.  There is something about the relationships you build in those times.  About 1 year in I asked many VCs about this and the feeling was nearly universal.  They said, “yeah, but we get that through our board interactions.  We build camaraderie there through the shared experience.  That’s true.  But it’s not the same.

3. I have to say “no” all the time – As an entrepreneur you’re used to hearing that what you’re doing won’t work and you turn up in the office every day to prove them wrong. My first company was a SaaS business in 1999.  Everybody said that companies would never put their documents “in the cloud.”  I was sure they were wrong and had the debate weekly.  As an entrepreneur you’re always focused on the “how can we find a way to make the impossible happen?”  People said that Google was going to dominate this market – we know we can do a better job.  You know, the Apollo 13 moment.  As a VC I’m required to say “no” ALL THE TIME.  I don’t enjoy it.  We get thousands of business plans per year.  I meet hundreds of companies.  We can only do a few deals per year.  Definitionally we say “no” many times per week.  I was with a very prominent VC on Sand Hill Road this week.  I always ask other VCs there thoughts.  He said the biggest disappointment since he moved over to VC was Tuesday mornings.  That’s when the calls go out every week to say, “I’m sorry but we’ve decided to pass.”  It’s much nicer to say “yes.”  [thank you to Tereza for reminding me I left section this out]

4. We are in a “get rich slowly” business - OK, I’m not complaining.  But I think many entrepreneurs have a misconception about this.  True, we’re paid better than many startup executives on an annual basis.  But I know many young partners in this business who have never gotten a “carry” check.  The upside for entrepreneurs is the equity in their business.  The upside for VCs is this carry.  If you have a $100 million fund you don’t get paid your carry until you return the initial money to your investors and then you typically get 20% of the profits above this threshold.  Well, since the industry hasn’t performed well in the past 10 years you have many younger partners who are still waiting for those checks.  That is in stark contrast to the late 90′s goldrush where VC partners made millions overnight as their companies IPO’d for crazy valuations.  On the positive side, we have a portfolio and therefore more diverse chances of success.  But there is no “sell early” option for VCs where a $20 million exit could change our lives.  But we obviously choose this side of the table. You’d have to be a pretty big baby to complain about being a VC.

Overall, I’m very happy on this side of the table.  I try to get my entrepreneurial fix in other ways:

1. Running a local community / mentorship program – I run a group called LaunchPad LA.  We’re gearing up to make big announcements about our second year program.  I’ll write about that in a couple of weeks.  I get to help control direction, make decisions and own results.

2. Writing this bl0g – This blog is a huge creative outlet for me.  I get to choose what I write about.  I might be controversial some times and get flack.  Other times I might get great results and approbation.  I can publish daily for weeks or not publish at all for a month.  I own the results.  I’m enjoying the chaotic creativity that comes with blogging.

I attended the inaugural Open Angel Forum in Los Angeles back in January and wrote about it here.  Jason Calacanis started this initiative in response to the pay-to-play network of angel events that he despised.  I’m a huge supporter of his initiative to help end this practice.

The first event was a big success and brought out many of LA’s angel elite.  It also attracted some big names from the Bay Area.  I know of at least 2 deals from that cohort that are either funded (Backupify) or nearly funded (can’t really disclose, I’m not sure if it’s yet closed and/or announced. But I loved it).  These were my favorite two deals of the night and everyone I spoke to liked the same two deals.  Some people liked the others but there was much consensus quickly.  This showed me that the system worked well.  Jason & Tyler brought forward 5 high quality companies and super high quality ones rose to the top and quickly got funded.  Success.

The second event was in Boulder.

Tonight’s event at the 5A5 Steak Lounge in San Francisco was even better than the LA event.  This was in large part due to the marketing efforts of Jason that created a great top end of the funnel (100+ companies applied) and the herculean efforts of Tyler Crowley who spent days going through all of the submissions and serving up 5 very interesting companies.  Also, the angels (some of whom are listed here) were very knowledgeable and insightful.  The San Francisco events will be run by Chris Sacca (of Lowercase Capital) and Kevin Rose of Digg.

There wasn’t a bad company tonight but I had a clear favorite.  I suppose I should keep it to myself but I guess Jason will be helping to hype up all the companies anyways.

My personal favorite and best fit for GRP Partners was Thumbtack.  Marco Zappacosta served up a cogent, business focused and nicely demo’d pitch of their product.  Thumbtack is marketplace for local services.  Like TechCrunch50 winner RedBeacon they solve the problem of people looking for local services – plumbers, nannies, contractors, etc. – and provide a way to facilitate a match between vendor and person needing service.  They’ve done some clever things to improve the trust factor like doing background checks and other verification techniques to improve the trust people have in working with service providers.  I’d be SHOCKED if they weren’t funded pretty quickly.  Watch this space.  Then let’s hope both startups can build national practices.  For me the sooner we get this stuff out of Craigslist and into real systems the better.

Team Pip.io had a very ambitious project.  They called themselves a “social OS.”  Essentially I see it as two things: 1) an aggregator of social content from multiple places including Twitter, Facebook and soon even Gmail.  It has some similarities with Brizzly in this regard.  It serves a similar role as Digsby (which I love using) albeit from a social media metaphor rather than an IM metaphor.  In addition they are a platform (the OS part) where they’re encouraging developers to build third party apps on their platform.  The pro’s (for me) – the UI was simply beautiful.  The idea of aggregation is powerful in a world where your social communications are fragmented and increasingly hard to manage.  The potential risks – trying to achieve too much (complexity / breadth of scope worried me a bit), they didn’t seem to have a tight enough use case that they were doing better than anybody else (again, possibly too broad).  Overall, exciting team.  They may figure out something interesting and get focused over time.

As I’m sure Pip.io would acknowledge – they needed to get to the demo more quickly.  They walked through 4 minutes of PowerPoint garble (of a 5 minute pitch) before unveiling a beautifully designed UI.  Jason let them run over their time slot by a long time – the demo was worth seeing and he obviously knew this.  I wrote about how to give demos in a previous post.

The two most ambitious projects were ThereNow and IQ Engines.  ThereNow has build a platform (physical camera + software platform) to help remote coaches help improve teachers.  They ‘re cameras have the ability to show 360 degrees and can zoom closely.  The classroom activities are recorded and the video is appended with comments from a remote coach.  Ambitious goals.  My concern: teacher’s union and lobby.  In a system that so clearly should be “pay for performance” and is not – a tool like this could go a long way.  The problem is that to really fix education you’d need to reform incentives and pay in addition to better teacher training.  I for one will be routing for them, though.  The government has already given them millions in grants so it’s a good start.

IQ Engines is an image labeling and photo recognition platform that relies partly on technology to identify photos and party on a crowdsourced team of people who review the photos and tag them with the idea of the system learning and automatically becoming better through the process.  Having watched the history of Riya / Like I was a bit cynical of the ability of this group to get the image recognition to a high enough quality level.  That said, they have 9 PhD’s and 4 MBA’s on the team.  They have received grants from the NSF.  So if it doesn’t work it certainly won’t be for lack of intelligence!

Last two companies were Xachi Pet and Udemy.  The former is a toy / games company that merges the offline and online world in similar ways that Tamagotchi and Webkinz have in the past.  In this case it is novel because kids download iPhone game apps for free to play with them. The game then suggest that to super power them you can order a Xachi Pet for $40 to be sent to your house.  The game then interacts with the physical world product.  Pretty cool.  I love concepts that merge physical world and virtual world games.

Udemy is an online education platform similar to EduFire and others.  I first met the team at TechCrunch50.  They have come a long way since then.  Their product direction and demo increased 10x.  Still, I think that to succeed they really need to focus on vertical niches where they can differentiate and have more focus on content quality and user acquisition.  Given how much progress they’ve made since last year I look forward to tracking them and seeing where they end up by the end of 2010.

Finally, it was a real pleasure to meet Manu Kumar of K9 Ventures.  It’s always great to meet somebody in person that you’ve interacted with on blogs and on Twitter.  I was impressed with his knowledge and thinking after every presentation.  Also enjoyed sharing notes with Joshua Schachter who sat next to me.  Big thank you to Caine Moss of Wilson Sonsini and the chap from the LA recruiting firm who didn’t bring business cards (which is why I can’t remember your name – sorry) for sponsoring the event.

** Yes, the image above is from TWiST and not Open Angel Forum – but it’s the only one of Jason and Tyler together that I could find on the Internet.

Last night I attended the inaugural Open Angel Forum event started by Jason Calacanis, a fellow LA resident.  Jason started the Open Angel Forum in response to his frustration that entrepreneurs were being charged by some angel organizations to present at their events.  He wrote an excellent blog post on this topic.

As a former entrepreneur, I’m a big supporter of Jason’s goals.  Asking young companies with limited capital to pay to present to a group of potential investors is insane.  Yet many would-be entrepreneurs feel that they don’t have enough access to investors and that the opportunity to present to a group will help them short circuit the fund raising process.

This can be true if it’s the right event, but most of these events suck.  And frankly one of the skills of an entrepreneur is figuring out how to get access to people that they don’t know and one of the ways that potential investors (like it or not) can judge one part of your skills is in seeing how you use ingenuity to gain access.  If you want some tips on getting access I wrote a post on how to access VCs but the same logic applies to angels.

The event last night in Los Angeles was great.  Local angel investors totaled 18 people including Matt Coffin, Brett Brewer, Kamran Pourzanjani, Jarl Mohn and many others that young entrepreneurs would be blessed to work with.  Also present were NorCal angels including Ron Conway, Chris Sacca and Shervin Pishevar.  It was also great to spend time with the founder of TechStars, David Cohen, who will head up Open Angel, Boulder.

5 companies presented for 7-8 minutes each followed by Q&A.  2 of the companies were immediately interesting to me and I have already followed up with next steps, which I guess is testament to Jason’s goals of making sure that high quality, early-stage companies get funded.  In my next post I will write about one of the five companies.

Jason plans to set up Open Angel chapters in many US cities and eventually internationally.  My only suggestion to Jason would be to emphasize more of the presenting companies being local.  I think most great angel investing is done at a local level.  At the earliest stages of a company you want to raise money from people local to you because distance = their time, attention and focus.  And that’s really what you want.  It was great to meet some promising companies from outside the area but 4 out of 5 wasn’t the right balance for me, personally.

There was some Twitter chat before the event about whether this “replaces” local angel funding communities like the Tech Coast Angels.  It does not and that’s a good thing.  While TCA has had it’s challenges (and updating your website certainly wouldn’t hurt your image, guys. Seriously, it kinda stinks) it is a legitimate funding source for Southern California entrepreneurs and has produced successes including GreenDot and MyShape.  We don’t need competition – we need more overall organizations like Jason’s to helping young entrepreneurs more easily reach angel investors with no payola.

Hat’s off to Jason – you’ve started something important and of great substance.  I look forward to tracking the progress.

Oh, and hats off to Tyler Crowley and Alex Miller, the magic guys who really do much of the work behind the scenes to pull off these great events that Jason dreams up.  They deserve more credit.

This is part of my series on Raising Venture Capital.

I’m sure I’ll spark the ire of some VC’s for saying so, but there is certainly such a thing as black-out days in venture capital.  It’s worth you knowing this so you don’t waste your time.  It’s also very important to understand so that you can properly plan when you raise money.

Let me first tell you the black-out periods and then I’ll explain why.  It is very difficult to raising venture capital between November 15 – January 7th.  It is also very hard to raise VC from July 15 – September 7th.  (you need to have had your first meeting even earlier.)  If you’re thinking about raising VC and have not yet started the process, you’ve probably already missed the boat for 2009.

If you’ve had your first partner meeting but haven’t had the full partner meeting then you had better schedule it for Monday, November 23rd.  Full partner meetings are almost always on Mondays and if it isn’t already booked yet for Monday, November 16th (e.g. this coming Monday) obviously that’s not going to happen.  If your VC is reluctant to schedule the partner meeting by the 23rd it’s a clear signal that they want to wait until the new year (or they aren’t committed to your deal).

So why is Funding Season over for the rest of the year?  The VC process is almost universal in how it works across firms.  You meet an initial person from a firm – an associate, a principal or a partner.  If it’s one of the first two you’ll probably meet a single partner before coming into a full partner meeting where (by definition) all of the partners will be in attendance.

It’s true that some VC’s will work a few days of Thanksgiving week and many will work the first 2 weeks of December.  But the problem is that trying to get enough of the partners to be at a full partners meeting during  Thanksgiving week or in December is very difficult.  Because almost all VC’s know this, many are reluctant to even start the process with you.

The same thing happens beginning in the middle of July.  Many VC partners take 2-3 (4?) weeks off in August.  I know that many VCs also work in August so I’m not making any commentary about work ethics.  But enough take vacation that organizing full partner meetings proves difficult.

Maybe it’s partially because many entrepreneurs are pre-kids and many VC’s are post kids that VCs take off large blocks of time in the Summer?  Who knows – but trust me (regardless of what anyone tells you) it’s a true phenomenon.

Note that Jeff Bussgang says that VC’s work in August and he’s right.  VC’s are never really “off.”  Just like entrepreneurs they take calls from vacations, do board calls, handle company emergencies and urgent financings.  Jeff argues that his firm has done the most deals in August in the 7 years since he’s been a VC.  I’m betting these processes started much earlier and his firm was just finalizing what had been previously agreed during Funding Season.  Maybe I’m wrong but if I am I’m telling you in my experience his firm is the exception.

One carve out to the “Funding Season” rule – if you’re raising money from angels or small VCs (2-3 partners) maybe you can get something done as you don’t have the same scheduling conflicts.

But by and large I encourage entrepreneurs who are raising money to focus on the following time periods to START your process:

- January 6 – May 15th (green zone)

- May 16th – June 30th (yellow zone)

- July 1st – September 7th (red zone)

- September 8th – October 15th (green zone)

- October 16th – October 31st (yellow zone)

- November 1st – January 7th (red zone)

Please don’t shoot the messenger in the comments, I’m just tellin’ it how it is.  And if VC’s are telling you otherwise, when they’re done with your funding documents I’m sure they’ll also tell you, “the check is in the mail.”

UPDATE: As accurately pointed out in the comments, I advocate building relationships with VCs year round.  It is always best to know your VC well before you really need money (in the same way you’d historically want to know your local banker).  My guide to VC relationships if you haven’t read it.

UPDATE 2: Yes, this is US centric.  In Europe funding season is longer into November but much, much shorter in the Summer! (I know, I lived there for 11 years).  Any views on funding season in Asia?

Montgomery & Co Projects Deal Volume to Grow by 167% in Just 2 Years with No End to Growth in Sight

On the third Wednesday of every month I co-chair a meeting called the SoCal VCA (venture capital alliance), which represents participants from all of the top venture capital firms in Southern California as well as prominent members of the Tech Coast Angels (TCA).  We meet to discuss trends in the industry and to find ways to work together to help with SoCal deal syndication – somethings that happens automatically on Sand Hill Road in NorCal due to proximity.

We feature a prominent speaker at every event.  This morning we heard from Jamie Montgomery, CEO of the venerable Montgomery & Co investment bank who is at the heart of what is going on in M&A for venture backed companies.  They do around 7% of the total VC-backed deals in the US per year or just under 40 deals / year on average (present year excluded!)

I have to admit that I was greatly encouraged by Jamie’s outlook for venture backed companies, which if true will be a welcome relief for our industry.  No doubt a tech M&A banker would have a bias to say that the world ahead looks rosy, but however you want to put a spin on the next 2 years I think you’ll find this data very interesting and useful.  Where I add commentary from myself or my fellow VC colleagues from our discussion after Jamie left I’ll put in red.

Summary of Montgomery & Co’s views on the road ahead for tech M&A of venture backed companies:   (the whole presentation is later in the post, which I suggest you look at because it has insightful data.  If you want to download the document I’ve made it available at my favorite document sharing site DocStoc).

1. 2009 has been the worst year for M&A in a decade.  The total number of M&A deals in the US this year is projected to be a paltry 225 transactions relative to more than 450 deals just 2 years ago, which was the norm between 2002-2007, varying only by around 3% per year.  Projected IPOs for 2009 are an embarrassing 10 total deals, down from 86 just 2 years ago (it was 265 in the go-go years of 99-00) but at least up from 6 in 2008.

2. Montgomery expects M&A to rebound to the normal recent levels at 450 deals by 2010.  They have data from surveys they did with corporate development officers (e.g. the people who buy companies) in Q2 of this year of technology & media companies.  Nearly 50% say they will increase their activity levels in 2010 (hallelujah!) with only 19% saying they would decrease levels.  Jamie believes that if he were to poll corporate buyers this month (e.g. Q4) the number of buyers expecting to pick up activity would be greater than 80%. Montgomery believes there will be 50 IPOs in 2010 as there is pent-up supply and a higher risk tolerance amongst institutional public investors harmonizing at 40 deals / year for the 3 years starting in 2011.

Fred Wilson supports Montgomery’s view in this thoughtful post on the return of the tech IPO market.  Bill Gurley of Benchmark Capital hopes IPO’s will pick up in this CNBC Video but stopped short of saying it would for sure.  He thinks demand for IPOs (from buyers) remains high while supply is low because Sarbanes Oxley amongst other things has made less CEOs want to go public.

3. More interestingly Montgomery expect the M&A market to grow to 600 in 2011 and 750 in 2012.  This would be a whopping 233% increase from today’s levels and 66% above the average of the years just preceding the current recession.  The believe several factors will drive this growth:

• VC’s have a supply of companies they need to sell: There is a huge pent-up supply of venture-backed companies.  VCs are typically “closed-end” funds, which means that we are expected to sell our positions in companies within a pre-defined timeframe and return the money to our shareholders.  This time period is usually 10 years (although small extensions are common).  They cite 800 VC-backed companies that are now > 10 years old and this number would more than double to 2,000  within 18 months if M&A doesn’t pick up.

• Strategic investors are looking to consolidate their positions: The top 6 buyers in tech & media account for 27% of all purchases.  And look at this post by Paul Kedrosky showing how much cash Microsoft, Apple & Google have!  With 50% of buyers suggesting in a Q2 survey (possibly 80+% now) they will increase their pace of investment and a further 33% holding flat this argument is for more deals.  

• More IPO filings will drive M&A: There is a truism that the best way to be sold is to register for an IPO.  Buyers tend to come out of the woodworks and realize that it would be easier to buy you as a private company so it’s sort of one last look.  A recent example would be Compuware’s $295 million acquisition of Gomez, a networking monitoring company.

• A secondary market for buying private companies will likely emerge:  The final point we all discussed was a secondary market for acquiring VC positions.  A secondary buyer is someone who buys either specific positions from a VC or buys their whole porfolio.  What drives this is often the need for the VC to return money to its investors due to the end-of-life nature of its fund.  Right now this isn’t robust because the buyers are bottom-feeders (e.g. cheap) but there was a sentiment that some funds will likely be raised in the next 3 years to buy out VC positions at more fair valuations.

What have been your experiences in the past 6 months?  What are your predictions for the road ahead.  Love to hear more views!

M&A Outlook for 2010 / 2011 –